Scholz Homes Inc. v. Larson

Plaintiff Scholz Homes, Inc., an Ohio corporation, granted a franchise and sold an inventory of materials to Pacific Fabricated Structures, Inc., a California corporation, referred to by the parties as FABSCO, organized by Bernard Perry and Bruce Kilby. The contract was signed August 19, 1960, a few days after incorporation of FABSCO. In 1962 plaintiff Scholz brought this action*fn1 against Lee (Lavern E.) Larson and Roger Kilby, father of Bruce Kilby.

Larson and Roger Kilby had subscribed for stock in FABSCO before its organization, and plaintiff Scholz alleged that it relied on these subscriptions. Neither Larson nor Roger Kilby paid in any capital. Count I alleged fraud in certain particulars, and Count III alleged breach of contracts of which plaintiff was third party beneficiary.*fn2

In May, 1965, there was a lengthy trial before the late Senior District Judge Fred L. Wham, without a jury, on the issue of liability only. Judge Wham became ill before reaching a decision. The parties stipulated to proceed to disposition before Chief Judge Campbell on the record made before Judge Wham.

July 15, 1966 Judge Campbell found defendants liable on Count I (fraud) and stated that he made no decision with respect to Count III (contract). The issue of damages was later tried, and on July 13, 1967, judgment was entered in favor of plaintiff Scholz for $99,955.81 and costs. Defendants appealed.

Before August, 1960, Scholz had a branch in Long Beach, California, engaged in making and selling prefabricated homes and other structures. In July, 1960, Burke, vice president of Scholz, conducted negotiations with Bruce Kilby and Perry. They contemplated sale of Scholz's California assets to a corporation to be organized by Bruce Kilby and Perry.

FABSCO was incorporated August 15, and the contract signed August 19. Scholz granted FABSCO an exclusive franchise to manufacture and sell prefabricated house packages under the Scholz trade name in California and several other states and FABSCO promised to pay royalties. The contract also provided for sale of Scholz's Long Beach inventory and related assets to FABSCO for $120,000. Temporarily the proceeds of sales were to be accumulated in escrow, and Scholz was to be paid $25,000 out of this fund. Scholz received notes for $20,000 and $37,500. The agreement does not specify how the remaining $37,500 was to be paid, but this appears to have been accomplished by a cancellation of that amount of indebtedness owed by Scholz to Signal Lumber Co. Signal had had transactions with Scholz, was its landlord, and was to be the landlord of FABSCO.

Scholz acknowledges that the entire purchase price was ultimately paid, except for the $20,000 note. FABSCO later went out of business and Scholz's damages claimed in this action included unpaid royalties and payments Scholz made under a guaranty it gave to a concern which rented trucks to FABSCO.

The contract included a number of attachments. The formally executed portion included a representation that FABSCO had $40,000 in its bank account and a provision that Bruce Kilby and Perry would deliver a letter stating that FABSCO would have at least $100,000 paid-in capital, including $40,000 cash. One of the attachments was a letter addressed to Scholz and Signal Lumber Co., signed by Bruce Kilby and Perry, guaranteeing that when permitted by the securities commissioner, FABSCO "will receive forthwith paid-in capital of $100,000.00 including at least $40,000.00 in cash and the $60,000.00 White truck deposit." The letter also represented that in addition Bruce Kilby and Perry had secured the signature of two individuals (unnamed, but undoubtedly Larson and Roger Kilby) on a pre-incorporation subscription agreement for stock at a total price of $25,000, each.

Defendants rely on the inconsistency between the body of the contract and the attached letter, as well as other evidence, to support their claim that it was Signal Lumber Company and not Scholz who insisted on raising the paidin capital requirements to $150,000, and that Scholz did not rely on the Roger Kilby and Larson subscriptions. The district court found that Scholz did rely. There is evidence to support the finding and the finding is not clearly erroneous.

Although Judge Campbell did not have the advantage of observing the witnesses on the stand, he necessarily judged credibility, from the record, and drew inferences. The formula of "unless clearly erroneous" expresses as well as any other the depth of prima facie validity which must be attributed to findings in situations such as developed here.*fn3

On August 4 and 5, 1960 Perry had gone to Chicago and obtained the signatures of Larson and Roger Kilby on the pre-incorporation subscription agreement. As required by the California law, the agreement was made upon condition (1) that the corporation be incorporated within 90 days (which was fulfilled) and (2) that the corporation apply for and secure a permit authorizing the issuance of the shares "conditionally subscribed for." These conditions were known, of course, to Scholz. Each signer indicated that he was subscribing for 25,000 shares for a total purchase price of $25,000. Although the body of the agreement referred to payment "in cash or in services, as hereinafter set forth," the testimony indicated the payment was to be in cash, FABSCO, by resolution and its application to the California Commissioner of Corporations, treated the subscription as an agreement to pay cash, and the commissioner apparently took the same view.

On September 29 FABSCO applied for a permit to issue 250,000 shares: 50,000 shares for cash pursuant to the Larson and Roger Kilby agreement; 120,150 shares for cash to various persons, including the Kilbys, Perry, Larson, and Ballantyne of Signal Lumber Co.; 39,850 shares to the Kilbys for assignment of their contract with Economy Truck Sales & Services, Inc.; and 40,000 shares as promotional stock to the Kilbys, Perry, and Ballantyne, from time to time as other shares were sold for cash or other property.

The commissioner took the position that it would be unfair to use the pre-incorporation subscription agreement of Roger Kilby and Larson because it failed to disclose that FABSCO proposed to issue other shares for consideration other than cash (apparently the shares to be issued for the truck contract and the promotional shares). In order to meet this objection, FABSCO's attorney prepared letters to Larson and Roger Kilby releasing them from their subscription agreement, but stating that the shares "will be available for you" when the permit was granted. Roger Kilby received his letter. Larson did not, although he was apparently told in a later conversation that the permit had not been issued. Copies of both letters, dated October 5, were filed with the commissioner.

On October 14, 1960, the commissioner issued a permit authorizing sale and issuance of 170,150 shares for cash to listed individuals, including Larson and Roger Kilby, 39,850 shares to the Kilbys in exchange for their truck contract, and 40,000 shares to the Kilbys, Perry, and Ballantyne for promotional services. Issuance of the latter two blocks was subject to various conditions such as waiver of dividends. None of the shares was to be issued except to an approved escrow holder, subject to further order of the commissioner. An escrow holder was approved but no shares were ever issued, for cash or otherwise.

Months later there were separate negotiations with Roger Kilby and Larson about one or the other investing substantial amounts in FABSCO in order to make it viable. Each decided not to invest. The negotiations with Roger Kilby took place in February and September, 1961, with Larson in April, 1961.

Never having any capital, FABSCO ultimately collapsed. Its remaining inventory was turned over to another company in late 1961, and was destroyed in a fire. The latter company became bankrupt.

The district judge correctly found that the condition of the subscription agreement requiring incorporation within ninety days was fulfilled. He misconstrued the second condition as requiring only a diligent application for a permit, and found that had been met. The statute, as well as the agreement, however, required that the permit be secured. As we read the commissioner's file, the October 14 permit was issued only after the application was amended to disclose that Roger Kilby and Larson were released from the subscription agreement, because the ...

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